On Second Thought ��

The slow rollout of interactive services has forced many small tech firms to switch their business strategy. It's a risky approach--and sometimes the only way to survive.

A foolish consistency can be bad for the bottom line, as executives at many technology companies have discovered.

Take the case of Stellar One Corp., a privately held Redmond, Wash., company that spent eight years and more than $60 million trying to sell the cable industry on a set-top-box-and-software combination that would kick-start interactive television, long believed to be the industry's next big thing.

The problem is that interactive television has emerged much more slowly than originally thought. That, along with Stellar One's limited resources and lack of manufacturing prowess, convinced company executives to shift gears and license their software to others, rather than making their own set-top.

Such a radical shift in strategy presented a huge risk, but the move seems to have paid off. The small tech company recently secured $8 million in additional financing from existing investors, including Mitsubishi Electric Corp., and is "working to extend our software to other set-tops," said Dennis Sullivan, vice president of corporate marketing and content at Stellar One. The company is in talks with four manufacturers about possible deals, although Sullivan declined to provide specifics.

Indeed, Stellar One is just one of many technology companies that have made wholesale changes to their business plans or looked to new markets in order to survive a combination of perilous business factors, including the slack economy and the slow rollout of broadband and interactive services.

"At the heart of the matter for many technology companies is, if the business model isn't working, how can they make money in the U.S. when there are so few deployments" in interactive TV and other advanced services, said Jim Stroud, an analyst with the Carmel Group, a consulting firm based in Carmel, Calif.

He added that "deploying high-cost set-top boxes has been problematic for cable companies ... due to the lack of standards and high PC penetration into the home."

Perhaps the best-known strategic switch among tech companies recently occurred at ReplayTV Inc., which switched from a hardware to a software-licensing model, Stroud noted.

Based in Mountain View, Calif., ReplayTV announced late last year that it was cutting back its manufacturing efforts and changing its focus. Rather than selling its own personal video recorder to consumers, the company is licensing its software to third parties, such as cable companies and set-top manufacturers.

Replay was acquired this month by SonicBlue Inc., the creator of the Rio digital audio player. "The acquisition of Replay expands us into digital video offers including content, e-commerce and home networking," says Tracy Perry, a spokeswoman for SonicBlue.

Replay and its main competitor, TiVo, had maintained that partnering with cable operators and others was necessary to having the technology widely adopted. ReplayTV has already inked deals with TimeWarner, Comcast, Charter Communications and AT&T Broadband, as well as set-top maker Motorola to integrate hard-disk recording into digital set-tops.

Stroud has seen a glut of companies entering the broadband interactive services markets, which analysts have estimated to be worth billions of dollars, although not for another three or four years at the earliest.

Internet Cable Corp., for example, carved out a small business helping cable companies engineer and maintain their cable plants. Company officials had hoped to expand their services, offering end-to-end solutions to help cable companies implement new broadband subscriber services.

But the West Chester, Pa.-based company recently closed its computer-aided design division, overhauled its management team, moved to Markham, Ontario (the site of a subsidiary acquired last year) and laid off some staffers. Traded on the OTC, the company's stock was recently delisted.

New chief executive Joseph Melanson cited the slower-than-expected acceptance of the company's new services as well as the tight market for financing as reasons for the major changes.

"When the capital markets dried up, we stopped our aggressive plans to acquire several companies," he said, "We're downsizing to get back to a fiscally responsible level."

Internet Cable, with $10.4 million in sales and a net loss of $4.3 million last year, is in the midst of raising $2.5 million from private investors to help it get back on track, he said.

Melanson hopes to beef up its technology offerings through future acquisitions in order to help cable companies design Bellgrade digital systems.

ShareGate Inc. is another technology quick-change artist. The company hopes to expand its customer base in order to survive the broadband slowdown. Backed with $15 million in venture capital raised last year, ShareGate plans to launch its first product, a DSL-based voice and data residential gateway product, next month.

Founded in 1995, the company originally developed its gateway for use by power and utilities, said Douglas Infiesto, director of product management. But 18 months to two years ago, ShareGate accelerated development of a gateway for broadband telecommunications companies as the market for DSL started to take off.

"But the broadband DSL market hasn't really picked up as quickly" as many anticipated, Infesto said. "More and more, we're looking at our cable opportunities, which was always a part of our product roadmap.

"Clearly, we're accelerating our move to cable," he said.

The Carmel Group estimates that five million subscribers this year will use interactive services provided by Wink Communications, personal TV services such as Tivo and other customized offerings. But interactive services won't be widely available until 2003 or even 2004. "That's when it will really take off," Stroud said.

"To survive, middleware providers are going to have to partner with set-top makers and even partner with MSOs," he said. "It's obvious that interactive TV will be a success but only when standards are set, content is more available and systems are more flexible."

Executives at Stellar One agree with that timetable, which is one reason they have shifted gears.

The company originally engineered a costly, sophisticated set-top box and software system that allows both cable and telecommunications companies to offer interactive television services. When cable companies were slow to upgrade their systems to digital, the company went after telecommunications providers.

Stellar One saw some initial success, selling services to startup Myrio Corp. and various telecom companies overseas. But that market has been slower to take off as well, and executives realized that their set-top box was still too costly to make, Sullivan said.

So late last year the company slashed its staff, shifted gears and decided to sell its software to others. The company raised the $8 million as a bridge from existing investors, which include New World Development Co. Ltd., a Hong Kong conglomerate, Mitsubishi Electric Corp., Benaroya Capital Co., a Seattle investment firm and local Seattle businessmen.

Stellar One also broadened its market-segment focus, adding cable companies and utilities as targeted customers.

Stellar One has inked its first major contract since the strategy shift, a $2.5 million deal with Fujitu-Siemens Computers, which plans to use its software in an upcoming product. The deal also means Stellar One will port its software to Microsoft Corp.'s Windows XP. The software was originally built on the embedded version of Windows NT operating system.

Stellar One's strategy also includes jump-starting its customer-acquisition efforts by helping customers secure content for their interactive systems, which executives view as a major reason interactive television has yet to take off. Company executives recently took part in conversations in Hollywood with major studios in a partnership with Verizon Avenue.

"We see a huge advantage of being able to offer content," said Sullivan, who is heading up those efforts.

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